Defining Issues
October 2016, No. 16-33
Contents
Current Capitalization Guidance ..... 2
Sale-leaseback Concerns ............... 2
Interaction with Revenue
Standard...................................... 3
Looking Ahead ............................... 3
FASB Decides to Retain
Guidance on Pre-production
Costs
The FASB decided to retain the current guidance on capitalization
of pre-production costs related to long-term supply arrangements
while it conducts outreach to decide whether it should propose
additional changes.1
The FASB also did not want to delay issuing its technical
corrections for the revenue standard, most of which did not pertain
to pre-production costs.2
Key Fact
The FASB decided to retain the pre-production cost guidance, in part, because
the revenue project did not include a broad reconsideration of cost guidance in
U.S. GAAP. The FASB will conduct additional research about what effects the
removal of this guidance may have on identifying performance obligations.
Key Impacts
Suppliers will continue to expense pre-production costs, such as tooling,
engineering, design, and development, unless the customer provides them
with a contractual guarantee of reimbursement or a noncancellable right to
use the tooling during the long-term supply arrangement.
Suppliers should still evaluate whether consideration received from a
customer for pre-production activities should be accounted for under the
revenue standard.3
U.S. GAAP would continue to differ from IFRS because there is no
comparable IFRS guidance that restricts capitalization of pre-production costs.
1
See the FASBs Tentative Board Decisions from October 19, 2016, available at www.fasb.org.
2
FASB Proposed Accounting Standards Update, Technical Corrections and Improvements to Update
No. 2014-09, Revenue from Contracts with Customers (Topic 606), May 18, 2016, available at
www.fasb.org.
3
FASB ASC Topic 606, Revenue from Contracts with Customers, available at www.fasb.org.
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 Defining Issues October 2016, No. 16-33

Current Capitalization Guidance

U.S. GAAP requires the supplier to expense design and development costs in
long-term supply arrangements relating to:
Products that will be sold; or
Tooling that it will not own, but that it will use to produce the related products.
However, U.S. GAAP requires capitalization if the supplier has a:
Noncancellable right to use the tooling; or
Legally enforceable contractual right for reimbursement of design and
development costs that can be objectively measured and verified.
The FASB staff observed on October 19 that having a noncancellable right to use
the tooling is similar to the concept of retaining control of the asset under the
revenue standard.
In May 2016 the FASB proposed eliminating its pre-production cost guidance,
which meant that the supplier would have applied the fulfillment cost guidance
in Subtopic 340-40 (created by the revenue standard).4 This could have required
certain fulfillment costs that are currently expensed to be capitalized because
the pre-production cost guidance in Subtopic 340-10 has a higher capitalization
threshold.5
The FASBs October 19 decision means that the supplier will continue to apply
current U.S. GAAP guidance on capitalization of pre-production costs associated
with long-term supply arrangements.

Sale-leaseback Concerns
At its October 19 meeting the FASB said that some constituents were
concerned that if the noncancellable right guidance was superseded, the
supplier could conclude that it has sold the tooling and entered into a leaseback
arrangement with the customer. The supplier may have reached this conclusion
because it would have a right to use the customers asset to produce the related
products.

KPMG Observations
It is unclear whether these transactions would result in a lease. That would
depend on whether the supplier, after transferring control of the tooling to
the customer, controls the use of the tooling. If the customer, rather than the
supplier, controls when, whether, and how much the tooling produces, the
supplier would not direct the use of the tooling under the lease identification
guidance and therefore a lease would not exist.6 However, even if the sale-
leaseback concerns are valid in some cases, the decision to retain the pre-

4
FASB ASC Subtopic 340-40, Other Assets and Deferred Costs Contracts with Customers,
available at www.fasb.org.
5
FASB ASC Subtopic 340-10, Other Assets and Deferred Costs Overall, available at www.fasb.org.
6
FASB ASC Topic 842, Leases, available at www.fasb.org.

20012016 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
2 KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative, a Swiss entity.
 Defining Issues October 2016, No. 16-33

production cost guidance would not alleviate those concerns. Under the
revenue standard, situations may still arise when tooling arrangements result
in the transfer of control of an asset to a customer.

Interaction with Revenue Standard

Even with the decision to retain the pre-production cost guidance, the supplier
will still need to evaluate whether tooling and other pre-production activities
would result in the transfer of control of a good or service to the customer for
which it is entitled to consideration. For example, in a situation where the
supplier does not have a noncancellable right to use the tooling (because both
title and control transfer to the customer), and has a contractual guarantee of
reimbursement from the customer, it may be reasonable to conclude that tooling
is a separate performance obligation under the revenue standard. The supplier
will consider the guidance in Subtopic 340-10 to account for the related costs.
If the FASBs outreach efforts result in a decision to eliminate the pre-production
cost guidance, there are scenarios where the costs would be capitalized as
fulfillment costs under Subtopic 340-40. For example, if the supplier does not
have a noncancellable right to use the tooling nor a contractual guarantee of
reimbursement from the customer, then those costs may qualify as fulfillment
costs associated with a contract or anticipated contract for the sale of the related
parts. With the retention of the pre-production cost guidance, the supplier would
be required to expense those costs as incurred.

Looking Ahead
We encourage suppliers to consider the potential effects of the FASBs decision
to retain the pre-production cost guidance on their financial statements,
performance measures, and compensation arrangements. The FASB staff will
contact preparers and auditors to understand some of their concerns and
potential effects that may result if the Board decides to change the pre-
production cost guidance.

Contact us: This is a publication of KPMGs Department of Professional Practice 212-909-5600

Contributing author: Daniel L. Langlois

Earlier editions are available at: http://www.kpmg.com/us/frn

LegalThe descriptive and summary statements in this newsletter are not intended to be a substitute
for the potential requirements of the proposed standard or any other potential or applicable
requirements of the accounting literature or SEC regulations. Companies applying U.S. GAAP or filing
with the SEC should apply the texts of the relevant laws, regulations, and accounting requirements,
consider their particular circumstances, and consult their accounting and legal advisors. Defining
Issues is a registered trademark of KPMG LLP.

20012016 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
3 KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative, a Swiss entity.